“Hold on, man. We don’t go anywhere with ‘scary,’ ‘spooky,’ ‘haunted,’ or ‘forbidden’ in the title.”

~ Shaggy, in Scooby-Doo

Many people think bankruptcy is a pretty scary thing. Troubled corporations rising from the ashes of chapter 11, “hell-or-high water” provisions, chapter 13 proceedings, vulture funds, drop-dead clauses, stalkers (at least stalking horse bidders), plan of reorganization death traps, and debtors in “possession” are only a few of the spooky themes in the world of bankruptcy. For the Halloween edition of the Bankruptcy Blog, we’ve decided to share some of the highlights of the scariest, spookiest, Halloween-themed cases that have arisen in connection with bankruptcy proceedings. Read on … if you dare.

Spooky: Watch Your Mouth When Dealing with Core and Non-Core Matters

In the United States Court of Appeals for the First Circuit, Spookyworld v. Town of Berlin (In re Spookyworld) is probably known best for being the decision where the First Circuit sided with the Second, Eighth, Ninth, and Eleventh circuits in holding that corporations are not “individuals” and are accordingly not entitled to the strong arm of section 362(h) of the Bankruptcy Code. More recently, the attention that Stern v. Marshall has called to bankruptcy courts’ authority to issue final judgments and orders highlights Spookyworld’s other haunting message – namely, that parties seeking to appeal mixed core and non-core matters should take particular care in filing proper and timely notices of appeal when final judgment are actually issued with respect to any particular matter.

In Spookyworld, the title character – not surprisingly, the operator of a haunted house and “horror theme park” – commenced a chapter 11 proceeding one hour after local authorities secured a temporary restraining order forcing Spookyworld to close due to violations of local fire safety regulations. Spookyworld sought to continue to operate the theme park – which opened for only one month a year – by virtue of the automatic stay afforded by the Bankruptcy Code. One day later, local authorities forced the theme park to close, citing the police power exception to the automatic stay, as set forth in section 362(b)(4) of the Bankruptcy Code. The debtor then sued the local authorities for violations of the automatic stay and for various other claims, including (among others) libel, slander, and section 1983 claims.

The bankruptcy court ruled that the automatic stay claim was a “core” matter and granted the defendant’s motion for summary judgment with respect to that claim, as the authorities’ actions to close Spookyworld were within the police power exception to the automatic stay. Then, ruling that the other claims were “non-core” claims, the bankruptcy court issued proposed findings of fact and conclusions of law recommending that the district court grant the defendants’ motion regarding those other claims. Notably, an appeal of the bankruptcy court’s report and recommendation would have been premature, as it was not a final order. Rather, Spookyworld should have interposed an objection to that report and recommendation.

The debtor did not file any objections to the report and recommendation on the non-core matters but, instead, appealed the court’s decision as to the claim for violation of the automatic stay. Seeing no objections regarding the recommendation in favor of the defendants regarding the non-core claims, the district court summarily adopted the bankruptcy court’s report and recommendation regarding those claims. Over a year later, after a more protracted appeal regarding the core claims for violation of the automatic stay, the district court affirmed the bankruptcy court’s order dismissing the remaining claims. The debtor then filed a notice of appeal indicating that it would appeal “the Order of Dismissal of the District Court dated 1/23/03 affirming the decision of the Bankruptcy Court which allowed the Motion of Defendants . . . for Summary Judgment.” Because the notice of appeal only referred to the order resolving the core claim, the First Circuit concluded that such notice was insufficient to inform the defendants or the court of the debtor’s intent to appeal the district court’s adoption of the bankruptcy court’s report and recommendation as to the non-core claims. Moreover, the court also held that any appeal of that order was untimely, as the order regarding the non-core claims was entered over a year before Spookyworld filed its notice of appeal, and the debtor’s appeal from the “non-core claims” order was, therefore, barred. For both of these reasons, the First Circuit ruled that the proverbial ship had sailed regarding Spookyworld’s right to appeal the district court’s order adopting the bankruptcy court’s report and recommendation as to the non-core claims.

In light of the recent increased attention to, and distinction between, core and non-core matters, parties to disputes such as those at issue in Spookyworld should carefully consider when a final judgment is entered with respect to each discrete element of such dispute – whether that final judgment is issued by the bankruptcy court or the district court. A failure to pay attention to the “Day of Final Judgment” may not summon the Grim Reaper’s ire, but it could cause parties to lose their opportunity to seek appellate review.

Spookier: The Headless Pregnant Woman in the Heavy Metal Graveyard

On a different note, in HRPCreative Servs. Co. v. FPI-MB Entmt., the United States District Court for the District of Delaware was faced with a motion from HRP Creative Services (which was affiliated with certain bankrupt entities, but was not itself a debtor) to enjoin FPI-MB Entertainment from opening a theme park that would have purportedly infringed on certain intellectual property rights held by HRP. HRP and its affiliates had owned and operated a “Hard Rock” theme park, which subsequently failed. Some time later, FPI bought the park, while HRP retained certain intellectual property rights regarding the theme park and the “Hard Rock” brand. The court declined to enjoin FPI from opening the new theme park, ruling (among other things) that HRP would not face irreparable harm if the park were allowed to open, as whatever value associated with its brand would not be diluted because FPI had made substantial changes to the theme park and visitors would not associate the redesigned theme park with the Hard Rock brand. Among those critical changes, FPI changed the “Monstars [sic] of Rock” ride, removed a hermaphroditic “Heckle Cow” with squirting udders, creatively repurposed many drug references and icons, and removed the statues in the “Heavy Metal Graveyard” (including one of a headless pregnant woman with a protruding hand making the “rock on” symbol), converting the site into a rock garden with large chia pets and pet rocks. While we make no judgment as to which theme park would have been more fun, in the spirit of the season, we note that HRP sheds critical light on the important distinctions between a morbid statuary and a chia pet topiary.

Lastly, we leave you with a warning that evil zombies in bankruptcy courts may survive all attempts at eradication. In Scholes v. Lehman, Judge Posner articulated the so-called “evil zombie rule,” noting that corporations in receivership can recover assets that were unlawfully dissipated by the corporation while it was a “robotic tool” of its former control group – delicately referred to as “evil zombies.” Once the corporation is freed from an evil zombie’s spell, it may be entitled to recover funds that had been diverted by the evil mastermind for unauthorized purposes. In other words, the Scholes court suggested that “the defense of in pari delicto loses its sting when the person who is in pari delicto is eliminated.”

Other courts interpreting the “evil zombie rule” have held that evil zombies are never truly removed from corporations that subsequently commence bankruptcy cases. For example, in Sender v. Buchanan (In re Hedged-Investments Assocs., Inc.), the Tenth Circuit held that a bankruptcy trustee’s standing is limited by section 541 of the Bankruptcy Code, pursuant to which the appointed trustee is given control of “all legal or equitable interests of the debtor in property as of the commencement of the case.” In other words, the estate’s rights can never be greater than the rights that were actually held by the debtor. Indeed, it is not a novel concept to hold that bankruptcy trustees and debtors in possession stand in the debtor’s shoes and are subject to the same defenses that could have been raised against the prepetition debtor, including the in pari delicto defense. The Sender court, though, is perhaps the court to have articulated that concept most eerily, holding that even the most kindhearted and valiant bankruptcy trustees may not be able to rid debtors of the evil zombies that continue to haunt the corporations that they had once infested.

If you’ve made it this far, congratulations. Haunted houses, headless grave markers, and evil zombies are just a few of the exciting features you may come across in the wacky world of bankruptcy. Tomorrow, we’ll return to posting about the inner demons of the bankruptcy world.